Aluminum Costs Seen Dropping as LME Unclogs Depots: Commodities

A Novelis Inc. employee walks past rolls of sheet aluminum that sit stored ahead of cold rolling at the company's production facility in Yeongju, South Korea. Supply of aluminum is outpacing demand for a seventh consecutive year and will keep doing so until at least 2018, Morgan Stanley estimates. Photographer: Woohae Cho/Bloomberg

Oct. 7 (Bloomberg) -- The London Metal Exchange’s plan to
ease congestion at warehouses storing near-record amounts of
aluminum will accelerate deliveries and reduce premiums paid for
supply, at a time when prices are already near a four-year low.

Waiting times lengthened to a year or more in some
locations, driving premiums added to the LME price to a record.
Delays at depots spurred at least 16 lawsuits filed in U.S.
courts as well as scrutiny from lawmakers and regulators. The
surcharges, which rose almost 15-fold since 2008, are now
retreating as traders anticipate the changes, which are
scheduled to be reviewed by the LME’s board this month.

European premiums excluding duty will drop as much as 15
percent to $145 a metric ton by the end of the June, the lowest
since 2012, according to the median of estimates from 10
consumers, traders, producers and analysts surveyed by Bloomberg
News. Rising premiums boosted returns for smelters enduring
prices that at the Oct. 4 close of $1,844 a ton are now 45
percent below the record set in 2008. Plants on average need
$1,900 to break even, according to Wood Mackenzie Ltd., an
Edinburgh-based research company.

“We will see erosion of both physical premiums and the
price,” said Ronan Donohoe, the global head of metals and bulk
commodities trading at Deutsche Bank AG in London. “It needs to
occur to purge the high-cost production. This will mean some
short-term pain but it needs to be done.”

Second Quarter

The rise in physical premiums contrasts with slumping
futures. The LME’s benchmark three-month contract fell 11
percent this year and will average $1,900 in the second quarter,
when the new LME rules may start, the median of 13 analyst
estimates compiled by Bloomberg shows. Prices reached a four-year low of $1,758 in June.

This year’s decline in aluminum compares with a 1.4 percent
drop in the Standard & Poor’s GSCI gauge of 24 commodities and a
12 percent gain in the MSCI All-Country World Index of equities.
The Bloomberg U.S. Treasury Bond Index lost 2.5 percent.

Supply is outpacing demand for a seventh consecutive year
and will keep doing so until at least 2018, Morgan Stanley
estimates. This year’s projected surplus of 1.69 million tons is
almost equal to what Japan consumes in a year. While stockpiles
in warehouses monitored by the LME reached a record 5.49 million
tons in July and now stand at 5.35 million tons, Wood Mackenzie
says global inventories are about 14 million tons.

Nearby Delivery

Not all the metal is available to consumers, with Societe
Generale SA estimating that as much as 80 percent of the LME
stockpiles are tied into financial transactions. That typically
involves buying metal for nearby delivery while making a forward
sale to capitalize on a market in contango, where prices rise
into the future. Combined with the rising premiums, the
stockpiling has helped shore up returns for producers.

Financing is at its most profitable in at least 4 1/2
years, according to Macquarie Group Ltd. Aluminum for December
delivery traded at a discount of $130.50 to the December 2014
contract on Oct. 2, the widest since at least February 2009.

The LME is proposing to oblige warehouses where withdrawals
take more than 100 days to deliver out more metal than they take
in. The plans may already be altering the flow of metal to
depots, with average daily arrivals dropping to 5,849 tons last
month, from about 19,000 tons a year ago.

The consultation period for the changes ended Sept. 30,
just before the start of LME Week today. The annual event
attracts thousands of miners, refiners and traders for talks on
metals markets and supply contracts. This will be the first one
since Hong Kong Exchanges and Clearing Ltd. bought the bourse
for $2.2 billion in December. The board may not make a final
decision about its warehouse plan at the next meeting, Miriam
Heywood, a spokeswoman for the LME, said last week.

‘Unprecedented Intervention’

United Co. Rusal, the world’s biggest producer, said last
month that the LME should postpone the changes because it would
further distort the market. The “unprecedented intervention”
will accelerate the delivery of another 2 million tons onto the
market, Chief Executive Officer Oleg Deripaska said in a
statement Sept. 25. Alcoa Inc., the largest U.S. aluminum maker,
said it would harm producers without helping consumers.

The Midwest surcharge, the U.S. benchmark, will drop 22
percent to 8 cents a pound by the end of June, the Bloomberg
survey showed.

Even with the projected decline, premiums will still be
about 23 percent higher than the 10-year average, according to
data compiled by Bloomberg. Alcoa, based in New York, will
report a 2 percent increase in the most widely forecast measure
of profit to $267.25 million this year, the mean of 12 analyst
estimates shows. Shares of the company fell 9 percent to $7.89
since the start of January and will reach $8.20 in 12 months,
based on the average of 15 forecasts.

Warehouse Congestion

Rusal, based in Moscow, will report profit of $190.5
million, from a $55 million loss in 2012, the mean of seven
estimates shows. Its shares slumped 51 percent to HK$2.39 this
year and will rebound to HK$3.16 in 12 months, according to the
average of 14 predictions.

The LME’s plan won’t be enough to alleviate the warehouse
congestion that is increasing costs for consumers, a group which
includes the Washington-based Beer Institute and American
Beverage Association, said in a letter last month.

Global costs were inflated by $3 billion in the past year
by the “unfair” rules governing deliveries by depots, Tim
Weiner, a global risk manager at Chicago-based MillerCoors LLC.,
said in written testimony before his appearance July 23 at a
Senate hearing. Warehouses are owned by companies including
Goldman Sachs Group Inc., JPMorgan Chase & Co., Glencore Xstrata
Plc and Trafigura Beheer BV.

Capacity Cuts

Global economic growth that the International Monetary Fund
says will accelerate to 3.8 percent in 2014, from 3.1 percent
this year, still won’t be enough to erase the glut. Supply will
exceed demand by 350,000 tons next year, Deutsche Bank said in a
Sept. 25 report. Producers already announced capacity cuts of
1.4 million tons through the middle of next year and may add
another 500,000 tons to that by the end of it, according to the
bank.

The cuts may be offset by rising output in China, which
makes almost half of the world’s aluminum. Output there will
expand 7.9 percent next year and 8.1 percent in 2015, Deutsche
Bank estimates.

State Subsidies

Curbs may be partly delayed because of government
intervention to preserve jobs, according to the London-based
International Aluminium Institute, which represents producers.
At least 960,000 tons of unprofitable capacity from New Zealand
to Bosnia is supported by state subsidies, Deutsche Bank says.

“The high level of premium perpetuated by the queues has
been keeping a lot of smelters in business which shouldn’t have
been there,” said Colin Hamilton, the head of commodities
research at Macquarie in London. “The market has to rebalance
and it can only be balanced by shutting off capacity and you
need the prices to go down to shut off that capacity.”